Doubts over $400 million centrepiece of Australia's Pacific Solution

One pay-off for Papua New Guinea's agreement to resettle Australia's unwanted refugees was the construction of a glittering new $400 million hospital.

Now, amid a shortage of cash in PNG, that hospital development in the country's second largest city, Lae, has stalled, and the government in Port Moresby is hinting that Australia should increase its funding.

Implicit in this is a threat that if Australia does not inject hundreds of millions of dollars more into the hospital, it may threaten the future of the Manus Island detention centre.

Under the deal between Kevin Rudd and PNG Prime Minister Peter O'Neill, Australia would half-fund a state-of-the art hospital in a brand new building to replace the existing termite and asbestos-ridden facility in Lae.

But a budget crisis in PNG now threatens to derail the prized project, with officials hastily redrawing plans that had included a stunning stone and glass foyer, after PNG failed produce its half of the cash.

Fairfax Media has learned that the Foreign Affairs department this month pushed back the timetable for a tender to manage the multimillion-dollar refurbishment ,which had been expected to be advertised in November.

Australia has already pledged $207 million for the Lae hospital, commissioning an elaborate master plan to demolish the existing buildings and for new construction including a National Cancer Care Institute, emergency services and nurses' accommodation.

Draft tender documents released in December had anticipated that PNG would contribute "up to $150 million" towards the project.

Medical treatment in PNGCredit:Eddie Jim

But the collapse in global gas and resource prices has torn a hole in the PNG budget – and with it, Port Moresby's promise of matching funds. Health spending in PNG has been slashed by a staggering 37 per cent alone in the past year, according to recent analysis.

PNG's Minister for National Planning, Charles Abel, told local media last month there were "constraints".

"I have asked the Australian Foreign Minister [Julie Bishop] to go ahead with $200 million and get on and build the hospital," Mr Abel said.

"We need that hospital to be built quickly as it is vital to us."

The stand-off has also created gridlock in Australia's aid program for its closest neighbour, with charity groups privately complaining that the massive building project has distorted the aid budget and forced humanitarian spending onto the backburner.

"Any new contract for PNG is on hold until the money is found for Lae hospital," one aid worker said.

The financial squeeze also coincides with persistent claims about the damaging influence of corruption in PNG politics.

Police arrested the country's Attorney-General last week on charges of misuse of electoral funds, while this month the PNG Supreme Court cleared the way for an investigation into $30 million fraud allegations centred on Prime Minister Peter O'Neill. Top anti-corruption police have since themselves been suspended.

The hospital project poses a delicate challenge for Australia, which relies on PNG as host of the Manus Island detention centre as a major element of the so-called "Pacific Solution" to stop asylum seeker boats.

He had extracted a commitment from Kevin Rudd to help fund the rebuilt hospital as part of a bargain to never allow refugees to be settled in Australia – a promise reaffirmed by Ms Bishop during a visit to Lae in 2014.

But Ms Bishop also raised concerns over the maintenance of any new construction.

"We have committed to partner, go 50-50, with the PNG government to develop a new hospital. But it's got to be about more than just the building. A hospital is about the people who work in it, the people who manage it and the people who receive care there," Ms Bishop said at the time.

"The money will be spent, but we need to make sure that the equipment is maintained, that the infrastructure is maintained, that the workers in the hospital are trained."

But aid organisations worry the hospital rebuild – although needed – is not an urgent priority in a country bedevilled by high rates of tuberculosis and poor access to medicine.

Doctors and nurses from Mount Hagen hospital in the western highlands province held a fortnight sit-in protest last month over shortages of blood supplies and months without an operating theatre.

The Lae hospital – known as the ANGAU Memorial Hospital and named for the Australian administration during the years of colonial rule in PNG – was first built in the 1960s.

The hospital serves the 149,000 residents of Lae, according to the draft tender documents for the refurbishment, and the 675,000 residents of the surrounding Morobe province.

The Foreign Affairs department now expects a site office to be opened at the hospital in June and will continue to press PNG about possible co-financing.

Daniel Flitton is senior correspondent for The Age covering foreign affairs and politics. He is a former intelligence analyst for the Australian government and was at one-time a university lecturer specialising in international relations.